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Saturday, 21 November 2009

Islamic banking coming to U.S.?

Faithful Muslims don't eat pork. But that doesn't mean they can't enjoy bacon, because they can eat beef or turkey bacon.

The same logic can be applied to the Islamic banking system, said Islamic finance scholar Siddhartha Herdegen.

"They like the products" of conventional finance, he said. "They want it to fit into their religion."

Herdegen, who splits his time between Bahrain and Salt Lake City and received an undergraduate degree at the University of Utah, spoke Friday about Islamic finance at his alma mater to about 40 students and professors.

After the financial meltdown that resulted in the U.S. government bailing out banks last year, some people are questioning traditional capitalism. Some Islamic financing principals have been adopted by large Western corporations. For instance, General Electric Capital Corp. announced earlier this week they are going to issue $500 million sukuk, which is bond debt in a manner that is compliant with Islamic law called Shariah.

At the heart of Islamic finance is the question about whether money lent to a person or business would be used in a productive manner for society. Conventional finance tends to look more at outcomes.

"There are over 600 Islamic financial institutions throughout the world and about $1 trillion in assets," Herdegen said.

Islamic banks in theory have a 100 percent reserve ratio. "Under the Islamic finance, the bank has to use that money to buy physical things," he said. "It can't loan out more than its supply. It is, in essence, full-reserve banking."

Banks buy machinery, equipment and inventory, and sell them for a profit. Profits are given to depositors, who share the risk. In conventional banking, depositors are guaranteed to earn a percentage of interest on their money held in banks, Herdegen said.

Islamic financial products include murabaha, which is comparable to consumer loans in conventional finance, except getting money from an Islamic bank means paying more than the item is worth, which is similar to interest tacked on to a conventional loan. But paying back an Islamic bank loan ahead of time doesn't save money because many Muslims believe interest is detrimental to society, Herdegen said.

When Islamic bankers consider business lending, they look at the financial viability of a particular business in society. In conventional banking, a business owner's creditworthiness is considered important. Bankers don't care if a business fails as long as the loan is repaid. In Islamic finance, business loans are considered partnerships.

Bankers are silent partners in mudarabah loans. Musharakah loans are more like joint ventures, with the bank providing the business advisers.

With large Muslim populations in the West, Islam financiers have their eyes on North America. A handful of banks have been established in the Toronto area. Herdegen said that the United States is among the next growth region, especially since financial regulators have made recent rule changes to banking that permit Islamic financial practices.